House Subcommittee Studies Market Structure

On Feb. 28 the House Financial Services Committee's Subcommittee on Capital Markets and Government Sponsored Enterprises (GSEs), chaired by Scott Garrett, R-N.J., held a hearing titled "Equity Market Structure: A Review of SEC Regulation NMS."

In his opening statement, Garrett announced that a study of Regulation National Market System (NMS) is long overdue and that the Subcommittee will conduct one in conjunction with the Securities and Exchange Commission (SEC). The ranking Democrat, Carolyn Maloney, D-N.Y., endorsed the idea on behalf of Democrats. Unlike the hearing on the asset-backed securities market, where the agenda was to vitiate Dodd-Frank reforms and reconstruct the market in a form largely exempt from regulation, the agenda for the study and the landscape of client interests are unclear.

Members eagerly declared their admiration for the U.S. equity markets as "the envy of the world," with no apparent sense of irony that many of them said the same about the now-defunct housing GSEs, Fannie Mae and Freddie Mac, which are now under federal conservatorship and awaiting reconstruction with the explicit support of the federal government.

The testimony was marked by jargon like "market fragmentation," a lament that the monopoly rents once enjoyed by the New York Stock Exchange have been squeezed out. In a remarkable irony, the NYSE was recently acquired by a foreign market group incidental to its interest in dominating derivatives trading.

Steven Lofchie, a partner at Cadwalader, Wickersham & Taft, stressed the theme of "questioning assumptions," which would seem to be a good way to begin a study.

The assumptions to be questioned, Lofchie notes, are those on which regulation NMS, adopted in 2005, is based: 1) whether the "original intent" of the statute that gave rise to regulation NMS should be respected, given the changes that have occurred since the statute was adopted in 1975, when the NYSE enjoyed a practical monopoly of stock trading; 2) that transparency is always good, even when a market participant may have a legitimate reason for seeking to preserve anonymity; 3) whether, in the absence of a monopoly, an affirmative incentive should be provided for market makers to do their job; 4) whether more data are required or better interpretation in order to predict behavior would be more useful; 5) enforcement is a tool well-suited to preventing technology failure; 6) that for-profit exchanges are suitable to act as regulators of equity trading.

Erik Sirri, a finance professor at Babson College and former director of the SEC division of trading and markets, asserted that U.S. markets have done a relatively good job in providing liquidity and price discovery through more than a dozen registered exchanges and more than 60 other trading venues. He stressed that any review should also include fixed-income markets, where spreads are much higher than they are for equities, and the equities study should look at practices that might divert orders away from best execution venues.

Chester Spatt, a finance professor at Carnegie-Mellon University and former chief economist at the SEC, differed from Lofchie's position in calling for more data and more transparency in trading.

(Archived video, witness statements and the staff memorandum can be found here.)